Markets amok as Sword of Damocles hangs over France

France has become the latest country to feel the heat as it scrambles for an answer to Europe’s seemingly intractable debt crisis. But as jittery investors have shown over the past two days, markets are scarcely inclined to sit and wait.

It was bad enough for debt-laden and growth-starved countries having to deal with downgrades to their credit rating. Now it seems they have to deal with rumours of a downgrade too.

In a bid to stop the rot, France's market regulator, the AMF, warned of sanctions against anyone who fuelled or profited from rumours that have battered the shares of the country's leading lenders.

"The regular functioning of markets is altered by the spreading of unfounded rumours concerning financial assets listed in Paris,'' the AMF said in a statement on Thursday.

The spectre of a rating cut

Shares in leading European markets and in New York shed between 3% and 6% in nervous trading on Wednesday, despite assurances from the three main ratings agencies – Moody’s, Fitch and Standard & Poor’s – that France’s rating would remain stable for now.

France is widely seen as the most vulnerable of the six eurozone countries boasting a “Triple A” rating. It is the only one running a current account deficit and its debt costs the most to insure.

Furthermore, France’s market position has been weakened by the knowledge that French taxpayers, along with their German counterparts, would have to foot most of the bill if one of the eurozone's larger economies, such as Italy or Spain, were in need of a rescue. Analysts say France’s debt-saddled economy could ill afford such an effort.

For the time being, however, a downgrade of France’s credit rating would be “extremely surprising”, said Gunther Capelle-Blancard, a professor of economics at Paris I – Pantheon Sorbonne university, in an interview with France 24.

Another tabloid blunder

The slide in stocks on the Paris market was led by Société Générale, the French bank that made global headlines in 2008 after a “rogue trader” there single-handedly lost €4.9 billion, sending shockwaves throughout France’s banking industry.

In Wednesday’s trading, Société Générale shares briefly dropped 20% before recovering slightly to end the day down 15%. By midday on Thursday, they had shed another 4%.

The panicked selling of Société Générale shares, it later emerged, was prompted by an erroneous report published on Sunday, August 9, by the Daily Mail, a British tabloid, suggesting the French bank was “on the verge of collapse”.

“Any rumour can start a slide in share prices, and any bank could have been hit,” said Professor Capelle-Blancard.

As bank shares continued to slide on Thursday, the head of France’s central bank, Christian Noyer, dismissed in a statement “the unfounded rumours that are affecting French banks”, adding that strong results over the first term of 2011 had demonstrated the banks’ “solidity”.

But some analysts say Wednesday’s market drop underscores growing concern among investors that Société Générale and other French lenders have purchased excessive amounts of government debt issued by Greece, which remains at risk of a default despite multiple bailouts.

Totalling over €40 billion, the exposure of French banks to Greek debt dwarfs that of any other European country.

Société Générale announced last week its second quarter net profit slumped 31 percent to 747 million euros ($1.07 billion), largely because of its exposure to Greek debt that may never be repaid.

No time for leniency

The slide in French banking shares on Wednesday caused heavy losses in stock markets elsewhere, and nowhere more so than in Milan, which shed 6.7%.

Until investors shifted their gaze to France’s woes, Italy had been the main target of speculation.

Erratic markets have pushed the country’s borrowing costs close to the 7% mark that heralded bailouts for Greece, Portugal and Ireland.

Italy’s ballooning public debt is larger than that of any other eurozone member barring Greece. But unlike Greek debt, it has been ballooning for decades, without leaving markets overly concerned. That leniency has now changed.

“One of the effects of the global financial crisis in 2008 has been to heighten investors’ perception of risks in financial markets as well as the need for governments and companies to build trust,” said Andrea Greco of the Italian daily La Repubblica, in an interview with FRANCE 24.

Greco suggested markets were not behaving as irrationally as some may be tempted to believe. “The spotlight has finally fallen on a number of issues that Italy has failed to tackle for well over a decade, such as slow growth, lagging productivity, poor infrastructure and an oversized public sector,” he said.

The markets’ tolerance of European countries’ inability to reform their economies, it seems, has run out.

Italy’s Prime Minister Silvio Berlusconi has called parliament back early from summer holidays to vote Thursday on a constitutional amendment that would require a balanced budget. His finance minister, Giulio Tremonti, told lawmakers that he would push ahead with privatisations, plans to open up the market for local services, and moves to reform labour laws, thereby meeting demands set by the European Central Bank.

But unless Italy’s increasingly fragile government can secure an unlikely deal with trade unions and the opposition to overhaul the country’s economy, analysts say markets are unlikely to ease the pressure.

Punished for spending, likewise for cutting

In many ways, Italy’s woes are symptomatic of the wider problems afflicting the eurozone as a whole.

Restless markets have left governments with little choice but to cut left, right and centre, at the risk of pushing their sputtering economies over the edge.

But even the fiscally virtuous have been punished by investors – when they haven’t been ejected outright by disgruntled voters.

“Governments are running out of options and whatever they do, they get punished for,” said Professor Capelle-Blancard. “What had to be done was done in 2008, through stimulus packages to pull the economy out of recession. But you cannot keep on pulling off the same trick, and certainly not at a time of austerity.”

While markets have upped the ante, so has the head of the European Central Bank, Jean-Claude Trichet, who warned eurozone leaders on Tuesday to implement urgent structural reforms as they faced “the worst crisis since World War II”.

Like Berlusconi, he will have to prove to sceptical investors that he can also reform the country’s economy and set the groundwork for future growth.

But with elections looming and his popularity rate hovering around a lowly 25% according to Le Parisien on 5th August, he may well have neither the time nor the will to do so – and the dreaded markets know this.